Diageo - H1 2024 (Q&A)
January 30, 2024
Transcript
Debra Crew (CEO)
Good morning, everyone, and thank you for joining our interim results call for fiscal 2024. I hope you had a chance to read our press release and watch our presentation on diageo.com. The first half of fiscal 2024 was challenging, as we lapped high single-digit growth in the prior year and faced an uneven consumer environment alongside the inventory challenges in LAC. Performance in the half was in line with the update we issued in November. The group's organic net sales, or NSV, declined 0.6% in the first half of fiscal 2024, and organic operating margin declined by 167 basis points. Excluding LAC, organic net sales grew 2.5%, driven by good growth in Europe, Asia Pacific, and Africa.
Our group organic operating margin declined 53 basis points, excluding LAC, and that's entirely driven by an increase of 70 basis points in our marketing reinvestment rate. We unlocked a further $335 million of productivity cost savings across cost of goods, marketing, and overheads. We generated strong free cash flow of $1.5 billion, up $0.5 billion, while continuing to invest in the future growth potential of our brands. This is driven by strong working capital management, and once again, we increased our dividend up 5%. Specifically in North America, while NSV declined versus the prior year, we delivered sequential improvement when compared to the second half of fiscal 2023, as our actions and interventions in the region began to show an early impact.
We are focused on returning to high-quality share growth as the U.S. spirits category continues to normalize. Outside of the COVID period, this was the first time North America delivered operating margin improvement since the first half of fiscal 2018. In LAC, having conducted a review of inventory levels and monitored performance in the critical holiday season, we've taken action and have further plans to reduce inventory to a more appropriate levels for the current consumer environment by the end of fiscal 2024. Looking to the second half in this uneven global consumer environment, we expect our organic net sales growth rate to gradually improve compared to the growth rate for the group in the first half, and we expect an organic operating profit decline compared to prior year, but we expect the rate of decline to improve compared to the first half of fiscal 2024.
While the operating environment in the near term will continue to present challenges, I am confident that we remain well positioned and resilient for the long term. We are diversified by category, price point, and region, and we'll continue to invest behind our iconic brands to maintain our position as an industry leader in total beverage alcohol, an attractive sector with a long runway for growth. My focus is to generate long-term, sustainable value for shareholders by driving performance of our brands, meeting global consumers' evolving tastes, and stepping up our operational excellence to win quality market share. Thank you very much, and I'll now hand back to the operator for the first question.
Operator (participant)
Thank you. Again, if you would like to ask a question, please press star followed by one on your telephone keypad. If you would like to remove that question for any reason, please press star followed by two. Again, to ask a question, please press star followed by one. As a reminder, if you are using a speakerphone, please remember to pick up your handset before asking your question, and please do ensure that you are unmuted locally. Our first question today comes from the line of Laurence Whyatt from Barclays. Please go ahead. Your line is now open.
Laurence Whyatt (Head of European Beverages Research)
Good morning, Debra and Lavanya. Thanks very much for the questions. Three for me, if that's okay. Firstly, on, you, you said that you've been a bit disappointed by these results in the presentation that you gave, but have you seen anything in the last six months or otherwise that would shape your belief that the U.S. spirits market could grow at 4-5 medium term, and that you'd expect to take share within that market? And could that happen in 2025 or at least FY 2025? And is there any reason why you can't hit your medium-term total guidance range in FY 2025? Then secondly, on a Bloomberg interview that I saw, you mentioned that inflation was moderating, but it's still there. At your, your most recent CMD, you said that we should expect flat margins until inflation starts falling away.
Do you maintain that it would be impossible to see margin expansion in FY 2025? And then finally, on India, it's facing an election this year. Are you aware of any other regulatory changes that could possibly take place in this market in the sort of medium term, that might improve, reducing the regulation and help spirits sales? Thanks very much.
Debra Crew (CEO)
Thanks, Laurence. So I'll take your first one on just U.S. and medium-term guidance in fiscal 2025. And then, Lavanya, if you can just take the inflation.
Lavanya Chandrashekar (CFO)
Yeah.
Debra Crew (CEO)
And then India. So yeah, there's a lot to unpack there. So look, from a U.S. perspective, as I mentioned in the presentation, we are seeing, you know, it's still normalizing. It's not normalized. And, you know, and I mentioned it not being linear, and I would say, look, if you would have asked me six months ago, we were seeing, heading into summer, we were definitely, you know, looked to be tracking back into that mid-single-digit growth that you've seen the U.S. market consistently perform. Then fall came, and, you know, and quite honestly, we really saw, you know, a consumer more under pressure, and it was. It trended more toward low single digits than mid single digits.
You know, I mentioned I've been in the U.S. quite a bit over the past eight weeks, and, you know, talking with customers. I saw this bear out a little bit this morning in the NABCA data as well. You know, November, I would say, ended up being better than expected, so, you know, a nice improvement. Early December, I think customers were worried, but then December ended up, you know, people referenced the last week, particularly, of December trended better. And so, you know, you saw NABCA this morning, I think, had the industry 3.3%.
So, you know, I'm not seeing anything change in the fundamentals, particularly as we look at the medium to long term, that would say, you know, we know the number of drinkers, you know, and volume growth is really driven off of that. Also, spirits stealing beer and wine occasions, that hasn't changed. We're actually seeing that, including in this environment. You know, and then you look at pricing, what we're looking at, unlike what we've done the past couple of years, we're seeing pricing get back, you know, particularly if you're talking about in the U.S., you're talking about more on that kind of 1% range, if you look historically, and then it's really about premiumization. None of that, Laurence, I mean, you still see what's driving the category is Super Premium Plus price products.
So none of that has changed. It really is this near term kind of consumer sentiment, this normalizing into this post-COVID new normal. There's still supply chain noise. In our results, we had some supply chain normalization. We were lapping some replenishment on tequila, as an example. You know, so we're finally getting through that. We're finally getting through some of the price increases and lapping those. So that's why, you know, what we reference in our guidance for the second half, and then going into fiscal 2025, is as the consumer environment improves, we would expect the industry to improve. We would expect us to continue also to outperform that because nothing's changed in our portfolio either. If you take a look at what's growing, you know, tequila is driving the growth. We feel great about our tequila portfolio.
In fact, I'm very excited that I 100% own DeLeón, so we've got a broader super premium price portfolio that will help us on tequila. So there's nothing that's changed within the fundamentals that would make me say that the U.S. can't get back to mid-single digits. As far as when, I'm not predicting. I'm not gonna predict the industry. You know, could that be six months? Maybe, but you know, look, there's elections coming up, and it could be 18 months as well. I mean, we've just not seen this come back in a very even linear way. So that's why we've built our guidance the way we have. You know, look, it's January to be talking about fiscal 2025 already.
It's a bit early, but we wanted to, you know, let you guys take a look at what we were seeing. We do see progressing back toward mid-single digits, but a little early to call, you know, where the consumer environment's gonna be six months from now. Lavanya.
Lavanya Chandrashekar (CFO)
Yes.
Debra Crew (CEO)
Do you want to take the inflation question and then, India?
Lavanya Chandrashekar (CFO)
Sure. Laurence, on, on inflation, look, you know, what I- the word that I would use is, you know, it's a, it's an extremely volatile environment. With that, having said that, we are seeing, definitely seeing signs of inflation moderating. U.K. energy prices have definitely moderated here over the last, you know, period of time. We're also seeing more moderation, and, you know, corn has come down quite substantially. Aluminum is moderating. So definitely, I think that we are seeing commodities move in the right direction. And as we've always said, if as inflation moderates and the benefits of our Supply Agility Program kicks in, we will be able to get back to, you know, operating margin growth.
From a productivity perspective, I just draw everyone's attention to the $335 million that we have generated in productivity in the first half of this year, which is higher than any of the prior years, going back to fiscal 2020. You know, outside of LAC, our operating margin decline of 53 basis points is entirely, more than entirely driven by A&P, upweighting of 70 basis points. So, I do think that, you know, we're running this business in a very disciplined manner. Your second question on, your third question on India. Generally, during elections in India, what we've seen in the past is that there are temporary restrictions imposed by various states in terms of, like, the sale of alcohol.
So, I wouldn't, I, I think that would be something that we would anticipate. We know, the team in India know how to manage through that. They've, and, you know, I'm sure that they will continue to do a good job on that. More broadly, trend on regulations has been moving in the right direction in India. Several of the larger states have reduced, their state, you know, import duties or excise duties, on alcohol products over the last, call it, 18-24 months. You know, we're still hopeful around the FTA.
And, you know, we're expecting that the strong growth that we have seen on the Scotch business in India, 16% growth on Scotch, Johnnie Walker growing 21%, you know, with regulations moving in the right direction, I think this all bodes really well for Diageo as the largest player in this segment.
Operator (participant)
Thank you. The next question today comes from the line of Olivier Nicolaï from Goldman Sachs. Please go ahead. Your line is now open.
Olivier Nicolaï (Head of Consumer Staples Research)
Hi, good morning, Debra and Lavanya. Three questions, if I may. Just regarding LatAm, first of all, could you give us a bit more color on your inventories by type of product? Essentially, is it mostly primary Scotch, which is the issue, or is it actually more premium Scotch, such as Johnnie Walker, even Johnnie Walker Blue, where you need to see the de-stocking of? Second question, regarding the midterm guidance, you do not expect organic EBIT margin to grow ahead of organic sales short term and including in 2025. Is it driven by a specific region, such as North America, where you need to invest more, or is it a broad-based comment? And just lastly, Lavanya, just going back to following up on the presentation that you've done this morning.
Considering your Net Debt to EBITDA level and the higher interest rate environment, how should we think about the sustainability of the share buyback beyond full year 2024? Thank you very much.
Debra Crew (CEO)
Great. Thanks. I'll start with the Latin America, and then, Lavanya, if you can take the EBIT margin and share buyback questions. Look, so on Latin America, we've got. There's really two answers there. We've got Scotch. It's really Scotch and tequila. I mean, when you think about our Latin America business, it is, you know, it's a heavy Scotch business as well as there is, of course, tequila in Mexico. And what I would say is, as we've referenced, you know, there was a lot of premiumization in the region as we went through the COVID super cycle, and we have seen down trading. But I think your question's kind of getting to, is this sort of too much of the right stuff or too much of the wrong stuff?
What I would say is, look, in Brazil, it's just too much of the. But it, it's the right stuff, it's just too much of it. And it's, you know, it's in our Scotch portfolio. I would say in Mexico, where we're seeing some real down trading, you know, we probably do have too much of the premium tequila in that market. So, you know, two different answers for two different countries, but I think that should give you a scope. But, you know, I just will reiterate, from what we announced this morning, we've run multiple scenarios against this in the current kind of consumer environment, running multiple scenarios against that, and still feel confident that we can reduce the inventory to the appropriate levels by the end of the fiscal.
And so, Lavanya, if you wanna-
Lavanya Chandrashekar (CFO)
Yeah. So Olivier, on operating margin, is it—your question was, is it a specific region? What we're guiding to, let me actually start the other way around. In the first half of this year, if you exclude Latin America, we grew net sales 2.5%, with operating margin down 53 basis points. As I said, that was all entirely driven by marketing. Where did we increase our marketing investment? We increased our marketing investment to support the global tequila rollout, so that was primarily APAC and Europe. And we have seen, you know, strong results there. You know, tequila growth contributed to almost 19% of the growth of Europe, and equally in APAC as well. So, that's, and that's investing for the long term.
We are building a new category in these parts of the world. It's going well off of a very small base, but it is, it's an important investment for us. We invested in Johnnie Walker in Europe, which has grown double-digit, and we invested in India, which grew 9%. I gave the Scotch numbers earlier, you know, 16% growth, and we've invested in Chinese white spirits. And so, what does this tell you about our invest, how we approach A&P investment? Is that we invest where we see the best ROI possibilities. We are extremely disciplined about it, and where there is an opportunity for us to grow the business, both for the long term, but also, more immediately, and we see good returns, that's where we will make the investments.
So going forward as well, I would say that, you know, our investment strategy will continue to be the same. It's not like the cost to compete has gone up in one region or one market or anything of that kind. I think it's, we're, you know, we will be disciplined, and we'll, we'll approach each investment decision from that perspective. In terms of share buyback, you know, we've, after having a multi-year program, we have moved to having more of a year-by-year program. We announced a $1 billion share buyback program for this fiscal. We've completed $500 million. We will be completing the other half of it by the end of this fiscal.
We remain committed to our leverage ratio, the target range there being between 1.5 and 2 times, 2.5 and 3 times, sorry, between 2.5 and 3 times. I'm looking at a bunch of numbers here, sorry. And you know, yeah, and we will, we will stay very disciplined towards you know our leverage ratio as well. And if there's a great investment opportunity, we'll do what's right for the business. If we end up outside the range briefly, we will come back into the range. You know, this is a business that has a very strong balance sheet. We generate strong cash flow.
I mean, the $1.5 billion in cash flow that we generated in this half, which is up $0.5 billion despite operating profits being down, is a clear indicator of that.
Olivier Nicolaï (Head of Consumer Staples Research)
Thank you very much.
Operator (participant)
Thank you. In the interest of time, we request that each participant please limit themselves to the one question. Thank you. Our next question today comes from the line of Edward Mundy from Jefferies. Please go ahead. Your line is now open.
Edward Mundy (Senior Research Analyst)
Morning, Debra, morning, Lavanya. So one question for me to upon U.S. tequila. You, you pointed to some pockets of downtrading within the U.S. and also increased price competition within whiskey and tequila. You know, tequila has been a, a really strong growth engine for you, certainly over the COVID super cycle, and, you know, as you take a, a very long-term view, and you don't want to impact your brand equities from excessive promos, I mean, how do you protect your share within high-end, ultra-premium tequila?
Debra Crew (CEO)
Yeah, so I mean, Ed, I think there's a couple things just to dig into our U.S. tequila results, and then I'll talk about the market in general. You know, for one, our shipments in North America look a lot worse on both Don Julio and Casamigos than what we're seeing in depletions, you know, and ultimately what we're seeing at the point of consumption where we can track it. So, you know, as a for instance, Don Julio, our depletions were +12%. We also see that same kind of plus 11%-12% also in the Nielsen NABCA data, so you can really see, you know, it's still performing at double digits, but yet in our shipments, you know, it's showing up to plus 2%.
Likewise, Casamigos shows as a big negative, as a -14% in our results, but the depletion volume is actually positive. So, you know, that should tell you a little bit about last year Reposado, in particular, has been kind of the hot part of our portfolio, and it just took us longer to recover on that aged tequila. And so we were lapping that replenishment last year as well as some price increases on both of those. So we do feel better about the underlying performance of that ultra-premium tequila portfolio that we have. To your question about how do you handle the price competition going on?
You know, look, it was a really crazy. I would say, in particular, the last three months of the year, where it wasn't only within tequila, but also in other categories like cognac that impact ultra-premium tequila. You know, there were quite a competitive environment out there, and so, you know, certainly we don't want to take our these great, you know, brands that we've driven down into those, you know, competing at that level. That's why it's so important that we expand our portfolio. That's the reason I'm so excited about getting control of DeLeón. And also, of course, Astral came to us.
We bought that with the Aviation acquisition, and 21Seeds, that's been about a year or so that we bought that brand. So, you know, we are rounding out the portfolio to have the full price ladder, because we think that is important to be able to effectively compete across all the areas that, you know, that we're seeing in tequila. And tequila is still being driven, you know, that super premium and yes, ultra-premium's been under a little bit of pressure. I mentioned, especially when you get over $100 bottles, that's where you are seeing some down trading from those $100-plus bottles into, you know, really the aged tequilas, the Reposado and the Añejo, for us, is seeing a lot of heat right now. So, that's tequila.
Edward Mundy (Senior Research Analyst)
Thanks. Debra, do you think the downtrading from, let's say, the $50 to the $30, you know, the more cheap 100% agave, do you think that's due to the economic cycle, or do you think it's a little bit more structural?
Debra Crew (CEO)
I think. Look, there's been a lot of, you know, new competition out there and on, you know, at the shelf. I mean, people are, you know, out there experimenting. It's exactly what we would expect to happen. As the category gets big, you actually have people trying, you know, more and more. That being said, our household penetration, all the underlying pieces of our equity, people still feel very, very good. So I do think some of that is just the promotional cycle and just some of the, you know, the new entries of people going out and trying things. I think I tend to look at how brands are performing in on-premise and where they're calling it. Our on-premise performance in tequila is still very strong.
So, you know, this comes back to when people are paying for something, they, they wanna make sure they get the, what they want and the right thing. And so when they're calling drinks, you know, they're still calling, you know, Casamigos, and Don Julio in particular is, is really having a cultural moment right now.
Edward Mundy (Senior Research Analyst)
Great. Thank you.
Operator (participant)
Thank you. The next question today comes from the line of Celine Pannuti from JP Morgan. Please go ahead. Your line is now open.
Celine Pannuti (Managing Director)
Thank you very much, and good morning, Debra and Lavanya. My question is really a follow-up on this one on the U.S. I think, listening to your call this morning, it feels that there is more discussion about, or you're a bit more cautious about the U.S market, and we just discussed a bit more about the downtrading. So I also see that price mix is 1.4% in the half, and in the last two half, it was, which came from 7% to 0.8% and now 1.4%. So my question is, are we in an environment with more promo and downtrading, where we see the risk of that price mix even becoming negative? And then how should we think about the profit? Is that magnified, when you see down trading at your profit level?
Or is there a way that you can offset that? You've spent a lot on A&P. I presume when you sell a $100 bottle, you need a lot of A&P for that, but is there a way that you can offset? Should there be more pressure from the price mix standpoint? Thanks.
Debra Crew (CEO)
Yeah, I think what you're seeing in some of the price mix. Don't forget that that, like, for us, we were lapping, but honestly, I think it's quite broad across the industry. We're lapping now those price increases. So what you were seeing before was sort of this really historic kind of levels of price within spirits that came in last year in response to inflation. And so, you know, we fully lapped that within sort of the half. So you know, you see that price in particular come down. You know, look, that being said, what I would say is, you know, the promotional environment. I think a lot of it had to do with people were lapping big numbers from prior year.
You know, there is, you know, perhaps some people have more inventory out there that they were trying to do something with. We're not really seeing this being sort of something that's for the long term. I think this is really something in response to the particular environment that we're in right now. And then, Lavanya, if you wanted to say something about A&P or-
Lavanya Chandrashekar (CFO)
Yes. I just pick up on the price mix piece of it as well. The 1.4% that you referenced, Celine, is what you see in our accounts, so that's the shipment price mix that you have. You know, and that's been, in this half, that's been negatively impacted by the, what Debra referred to just a minute ago about our tequila, the lapping, the replenishment of inventory in the prior year. If you look at it from a depletion perspective, mix is significantly stronger. And, in fact, in my presentation, we did put up a slide where we kind of showed the difference between shipments and depletions in the U.S. on the Super Premium Plus price segments, where depletions, where shipments were down double-digit, I think 11%.
But when you look at it from a depletions and a consumption perspective, the picture looks quite different. And so, I do think that the underlying mix that we have within our portfolio is significantly better than what you're seeing in the accounts in the half. But as Debra said, you know, some of the extraordinarily high pricing that we have seen over the last two fiscals, last year, price for us was high single digits, the prior year was mid-single digits. You know, we are seeing that pricing come down both, you know, across our categories, but also more broadly, to the prior point on inflation, you know, moderating. On P&L, look, the more premium products tend to have better margins.
I mean, yeah, that's, that's part of what is, you know, that's how the structure of the category is. But what we have many levers to drive profitability within this business. I mean, volume is one of them. You know, what the work that we do on productivity helps us to offset inflation and drive margins. And as you have seen, we have done very well in the half, and we have guided to further stepping up our productivity to delivering $2 billion of productivity over the next three fiscal years. So that's definitely a help. We will continue to drive price, but in a very disciplined and surgical manner, and that will contribute to productivity as well.
A&P, it's, you know, A&P investment really comes down to where a brand is in its growth cycle more than anything else.
you know, as maybe Debra, you can add.
Debra Crew (CEO)
Yeah. Well, I think as you look at the U.S., to your question on... I mean, actually, our brands are actually at a pretty good rate. Where we're really investing in A&P, it really is in markets where we don't have quite the scale to be able to, you know, Lavanya mentioned earlier, you know, India, Chinese white spirits. Some of this are places where we're going after new occasions. You know, in Europe, we mentioned earlier a little bit about the tequila investments that they've made, the non-alc category that's going after new occasions. That's really where we're adding in A&P investment.
I would say from a U.S. perspective, look, we don't manage to a rate, but the U.S. team, you know, we're at good levels, and we look at that and feel like we've got what we need against those brands.
Celine Pannuti (Managing Director)
Thank you.
Operator (participant)
The next question today comes from the line of Sanjeet Aujla from UBS. Please go ahead. Your line is now open.
Sanjeet Aujla (Managing Director and Equity Research Analyst of European Beverages)
Hi, Debra and Lavanya. My question is just coming back to the medium-term guidance. You don't seem to be endorsing that 5%-7% for fiscal 2025, but should we still consider that to be a relevant framework for fiscal 2026 onwards?
Debra Crew (CEO)
Yeah, I think, look, what, what we're trying to give, like I said, it is January, so we're trying to give kind of an early look. And we're saying progressing back toward medium-term guidance at this point. It just wouldn't be prudent with the current consumer environment and some of the uncertainties in the macros to be able to say much more about it than what we have. But that being said, medium-term guidance is still what we're looking at. And as I answered on kind of the first question, I, you know, we feel very good about the fundamentals. We feel very good about our portfolio and where we're at.
I'm disappointed in the half because of the LAC performance, and you know, and we were disappointed by the North America share and you know, in missing that. We didn't miss by much, but we missed it. But we've got a second half, and the team has put together very strong plans. Always difficult to predict share, because you have to predict what competition's gonna do. But I feel very good about our plans on Crown, our plans on convenience. We've got some exciting innovation launches, and so we're you know, we're still very much bullish about our medium-term guidance. It's just the current operating context that we're in right now.
Sanjeet Aujla (Managing Director and Equity Research Analyst of European Beverages)
Got it. And just a quick follow-up on tequila again. You've spoken quite a bit today about the need to broaden the price ladder within tequila. How long does that take to meaningfully impact your performance? Is it a 6-12 months kind of timeline, or 2-3 years to build brand awareness on some of those smaller brands?
Debra Crew (CEO)
Well, listen, actually, on the half, if you take our total tequila portfolio, we did gain share in spirits. So already, we're getting some contribution, you can see from those brands. DeLeón, before, you know, the mess, we grew DeLeón 150% or so in fiscal 2023. So we feel very good about the brand. We understand the brand. And so to have full control of that, we're very excited about, and so see a lot of opportunity there. 21Seeds also, you know, we're feeling very good about that. Astral is just launching, so to your point of how long will that take? You know, we've got some markets that we're really kind of focused on, where we feel like it'll make the most impact to our portfolio.
But we are managing this as a total portfolio, and, you know, but I feel good about where we're at, and I think there's really great opportunities yet still to go.
Sanjeet Aujla (Managing Director and Equity Research Analyst of European Beverages)
Great. Thank you, Debra.
Operator (participant)
The next question today comes from the line of Simon Hales from Citi. Please go ahead. Your line is now open.
Simon Hales (Managing Director of Consumer Staples and Beverages Research)
Thank you. Morning, Debra. Morning, Lavanya. So I've got one main question, then just one quick clarification, if that's okay.
Debra Crew (CEO)
Sure.
Simon Hales (Managing Director of Consumer Staples and Beverages Research)
Firstly, I think we're all just trying to get our heads around, given the move to dollar reporting, what that means from an FX standpoint going forward. The, you've clearly indicated in the press release, you expect a big tailwind from transactional FX in the second half of the year, based on H1 rates. But I wonder if maybe, Lavanya, you could give a bit more clarity as to which currencies are driving that. And associated with that, I appreciate it's early, but when we think about transactional FX into the first half of 2025, I suppose I'm crucially trying to understand whether we see any unwind of that H2 2024 transactional benefit in 2025. So that's a slightly technical FX question.
And then, just to clarify, really, Debra, on Latin America, you said you were confident that the destock would be done by the end of 2024. I just wanted to check there isn't any assumption, therefore, going forward in your fiscal 2025 cautious guidance you've put out this morning of further destocking?
Debra Crew (CEO)
Yeah. So I'll take Latin America while Lavanya, you get to the FX.
Lavanya Chandrashekar (CFO)
FX.
Debra Crew (CEO)
I'm not gonna do FX. So yeah, just to be very clear on Latin America, we are not looking at that, you know, in relation to what we put out for fiscal 2025. In fact, I mean, actually, we would expect, you know, as we lap that inventory issue, that clearly gives us a bit of a tailwind, right? So that's actually a, you know, a good guy for fiscal 2025. That being said, it is a weaker consumer environment, right? That's part of how we got into this. So what we don't wanna do is overpredict, at this point, how quickly that consumer environment recovers in Latin America. So I would say the cautiousness in fiscal 2025 is really around the consumer environment in NAM and in LAC.
You know, that's really the cautiousness, but it doesn't have to do with the inventory. It's more about the consumer environment and not wanting to, you know, overpredict a steep recovery. So Lavanya, you wanna try to handle that FX question?
Lavanya Chandrashekar (CFO)
Yeah. So, on... Let me first start with this fiscal. I mean, Simon, so the second- for the full year, what we are expecting to see as the tailwinds on transactional FX really comes from, you know, the pound, the Mexican peso, and the euro versus the dollar. So that's our three big, you know, that's the three main currency pairs. And so that's where we are expecting to see the transactional FX benefit flow through. In terms of fiscal 2025, look, I mean, gosh, that's a long, long ways off, but, if- Here's how I would think about it. The two things that impact FX for us is, one is, of course, the prevailing rates, right?
Then the second is, you know, the hedge positions that we take. And especially on these main currency pairs, that's where we hedge on a rolling basis. And so, you know, I think, you know, those are the two things that I would look at to be able to build a model on what you would expect to happen on FX. We're not providing guidance for fiscal 2025 FX right now, and we will definitely come back with more clear guidance on it as we get into the fiscal year as we traditionally do. So July is when we do that.
Simon Hales (Managing Director of Consumer Staples and Beverages Research)
Okay. Thanks, Lavanya. Thanks, Debra.
Debra Crew (CEO)
Thank you.
Operator (participant)
The next question today comes from the line of Chris Pitcher from Redburn Atlantic. Please go ahead. Your line is now open.
Chris Pitcher (Managing Director)
Good morning, Debra and Lavanya. I've got a question on Latin America. In the presentation, you listed a, you know, an impressive list of initiatives underway to improve visibility, but many in other markets sort of raises the question, why are we not already doing things such as data sharing, independent stock counts, and investing more behind your sales resources? I mean, is it- would it be fair to say the region had lacked focus and resource for many years, and hence, in hindsight, the high operating margins you were delivering were unlikely to return to those?
As sort of a follow-up, with transatlantic freight rates to LatAm now down to pre-pandemic levels, have the economics of primary Scotches improved such that you can give brands like Black & White and White Horse a push again, and that could help capture some of the volume lost to down trading in Mexico and Brazil, but again, would limit the scale of any margin recovery in the region? Thanks.
Debra Crew (CEO)
Yeah. So, you know, a couple things on that. I'll take the, the resourcing, you can talk about transit, you know, Atlantic rates. But I will just say before I get into this is, yes, the team is really focused on. We do have a broad Scotch portfolio, and so we can absolutely, pivot to where the consumer's going down there. And actually, we do have, you know, great margins on our primary, portfolio as well. So, you know, I'll just get that one out of the way. So just talking a little bit about Latin America and, and what we're doing there, vis-à-vis sort of the rest of the world. This is a unique, it is quite unique in how we go to market, in Latin America compared to many of our other markets.
I think we talked about that a little bit with the presidents as we went kind of around the room at Capital Markets Day, and people talked about their various ways that we went to market that way. You know, Latin America is a place I've operated in it before in other categories, and it's not unique to our category, this multiple layer structure. And often, you know, first of all, you're never gonna have perfect visibility, but what you try to do is have enough visibility so that you can make so that your models and your estimates give you a better idea of what's going on with the inventory. It really was kind of a perfect storm of what happened to us because we were coming off of this COVID super cycle.
So I would say two things behind the resourcing that we had in Latin America. I would say, first, it was rapid growth in a region, remembering how much bigger, and frankly, more material it became to the group, in a very short time span. And so, hindsight being 2020, as we looked at the resourcing and the robustness of some of the models down there, we certainly have taken a look at that and said, "This isn't good enough." And so that's where we're making some additional investments, and making sure that really these models are much more robust. And maybe the biggest thing that didn't come through is it's about the frequency of which you revisit some of these pieces and, you know, and assumption.
I mean, you're not gonna be doing physical counts daily, but you need to do it frequently enough so that you're not making any misjudgments as you do some of these calculations and triangulation about what kind of inventory you have out there. So, you know, I would say we're upping the quality of the data, making it a real focus. You know, as you can imagine, we have a lot of governance around this, and these are activities that we have elsewhere. You know, I mentioned some of the technology stuff that we're bringing over from China. You know, China can be another place where you can have some of these issues, but we don't have these issues because we do have some of that technology in place in China.
So it is a matter of just, you know, learning from the rest of Diageo and bringing Latin America up to where, you know, the standard that we would expect it to be. And like I said, we've had great learnings there, and we are putting those into action to make sure that we do not have this type of misstep again. Lavanya, do you want to take the margin question around LatAm?
Lavanya Chandrashekar (CFO)
So, look, what I would say, Chris, is that, yes, we are going to be making some additional investment, but it's, you know, it's, it's, and some of it is going to be in overheads in Latin America. But Latin America, the nature of our business in Latin America is what drives our margin structure. And Latin America business is mostly a Scotch business, especially when you look at a market such as Brazil. And as Debra said, our margins are very strong on primary Scotches as much as the, as well as on the, of course, on the more premium Scotches. Overheads is a very small percentage of our net sales, you know, across the company, but more so in a market like Latin America, where a lot of our sales is run through distributors.
So, yes, we if we end up adding, I don't know, a dozen people, that's not going to move our margin in Latin America in any significant way. The reduction in freight rates, of course, helps us. It helps us for Latin America, but it also helps us across the world. So the structural economics of Latin America are not going to be materially changed here, because they are driven by the categories. And, you know, our Scotch sells at the same price point around the world. I mean, it has to, because it's a single product that we sell everywhere.
Chris Pitcher (Managing Director)
Can I just push you on that? If I look at the margins in Latin America, post the collapse of Venezuela, they averaged high 20s, 27, and then they expanded rapidly during the pandemic to the mid-30s. Are you saying that you expect to get back to mid-30s again, or is high 20s a much more sustainable margin in Latin America with the additional overheads it sounds like you need to put in?
Lavanya Chandrashekar (CFO)
Our Latin America margins got all the way up to the forties. Operating margin was in the forties in the last fiscal. And, you know, again, this was driven by, you know, two things. One, we have been very disciplined about taking pricing on our entire portfolio to offset the impacts of inflation and devaluation. We do this across all of our emerging markets, especially on our global portfolio of Scotches and tequila. We are very disciplined about that, because we do operate within... We do try to keep these brands to operate within a corridor of pricing around the world. And so that will continue to be the case. The second thing that helped us with margin improvement in Latin America was scale.
You know, the business has grown at a 15% CAGR over the last four years, and that has added significant scale to us and operating leverage, which has helped us to improve operating margins. Again, both of these are structured improvements.
Debra Crew (CEO)
Yeah. And supply agility. So, you know, we also, you know, have done some things within our supply geographic footprint that also has structurally, I would say, helped our-
Lavanya Chandrashekar (CFO)
Yes.
Debra Crew (CEO)
Our primary Scotch margins. So I... You know, look, we don't, we don't give out sort of margin guidance by, by region. But, you know, certainly there are things that have advanced, I would say, structurally in the market from that, you know, the period of time in the twenties.
Chris Pitcher (Managing Director)
Thank you. Thank you very much.
Operator (participant)
The next question today comes from the line of Sarah Simon from Morgan Stanley. Please go ahead. Your line is now open.
Sarah Simon (Head of European Consumer Staples)
Yes, morning. I've just got one question. On cash flow, you talk about it growing organically. Obviously, the first half, you had a very strong working capital inflow. What do you mean by organically? Thanks.
Debra Crew (CEO)
Lavanya, you want to-
Lavanya Chandrashekar (CFO)
Well-
Debra Crew (CEO)
Talk about cash flow?
Lavanya Chandrashekar (CFO)
We expect cash flow to grow for the year, Sarah. I mean, I think the word organic just, I mean, it implies that it is net of effects. But, you know, maybe because the question hasn't come up, I take this opportunity to talk a little bit about our working capital improvements that we have done here in the first half of the year, which I do expect that these are structural improvements that will continue to benefit us. You know, we've right-sized inventory. And again, inventories had increased, our days inventory in our system had increased through the COVID period, and that was simply because of the volatility in supply chains that we saw.
We've added quite a bit of data analytics and technology into the system to help us to get to the right safety stock levels. We've started to make some structural interventions as well in terms of where we hold inventory closer to the market versus in every market or, you know, holding it only in a market like Scotland. More of that will come through as we run through the Supply Agility Program. That will help as well. And we've made some structural changes on creditors as well, improvement of work processes, standardization of work processes, getting to better terms with suppliers as our contracts come up for renewal. So these benefits are structural, and I expect that they will continue.
Sarah Simon (Head of European Consumer Staples)
Okay, but when you say, I mean, obviously, the free cash flow in the first half was, the growth was exceptionally strong. Are you saying you expect materially? You're saying you're, it's going to grow organically, but can you give us a kind of range in terms of what that organic growth might be the full year, and then what that implies for the second half?
Lavanya Chandrashekar (CFO)
You know, the way I would think about it, Sarah, is two steps. One is, you know, cash flow is correlated to operating profit, and directly driven by operating profit. So as the business grows, and as operating profit recovers, you know, I would expect that cash flow will improve. The second thing I would say is, in terms of our days of working capital, we have seen an improvement, driven by some of the interventions that I just mentioned, and I expect that those interventions will... I mean, those are structural interventions. Those will continue. We are not going to go back to increasing safety stock and inventory levels back to kind of like the COVID period as we go forward. We will continue to invest in CapEx.
We'll continue to invest in maturing stock, as we have done in the first half of this year.
Sarah Simon (Head of European Consumer Staples)
Okay, thanks.
Operator (participant)
The next question today comes from the line of Mitch Collett from Deutsche Bank. Please go ahead. Your line is now open.
Mitch Collett (Director)
Morning, Debra. Morning, Lavanya. I'll ask one question. I think, Debra, you said in the U.S. that there's been no change to the fundamentals as you see it, but I think one possible change is that the growth in prepared cocktails appears to be cannibalizing the rest of spirits. And then on top of that, some of those cocktail players are now coming into the mainstream spirits category. So I guess I'd be interested in your thoughts on that and, you know, your strategy to fight that headwind, because so far, although I appreciate you've already got a big FMB business within ready to drink cocktails, you've very much gone for a premium multi-serve strategy.
With that in mind, I just wondered, you know, why you haven't maybe had a more aggressive push into mainstream single-serve canned cocktails, given that that's where the growth is currently? Thank you.
Debra Crew (CEO)
Thanks for your question, Mitch, because actually we haven't talked a lot about it, but we are launching our Smirnoff Smash Vodka Spritz in the second half. So we are getting a bit more into this canned cocktails, as well as we are expanding our Crown canned cocktails into a multi-pack of lemonade. So we certainly are into it. We have said we have a targeted participation in this ready-to-drink cocktail space. We are wanting to keep it premium. We are wanting to make sure that it is differentiated, and we wanna make sure that it adds to our brands and builds our brands. You know, to your point, we've been in the FMB space for a long time.
This can be a space where you're kind of in and out, if you don't do it right, and so we, we wanna do it right. So we're very excited about getting into, you know, a bit more mainstream on that, on those ready to drink cocktails. And you did mention, look, the ready to serve piece as well. We feel very, very good about the launch of Ketel One. The Espresso Martini and Cosmo are already showing up. You can see those in the database already reading through on Nielsen in a great way. And we do have the Tanqueray Negroni and Astral Margarita also launching in the second half. So we are upping our game, I would say, across convenience. You know, you mentioned, though, the fundamentals to this. Actually, we do not see it cannibalizing spirits.
If you take things in cans that are not beer, that has been fairly flat over the last, I'd say, three fiscals as we've looked at it. You know, you had quite a peak during COVID. But as you take a look, it really is sort of trading people up from that seltzer space, right? So seltzers are in a, you know, decline, and of course, that's still the bulk of those canned things that are not beer. And what you're seeing is growth in FMBs and growth in the cocktails in a can. So what we are seeing there actually is premiumization across that convenience cocktail.
Look, we're gonna plan it in the way that makes sense for our portfolio, and that will certainly, you know, help us from a share perspective and get us in the game. But yeah, we're not seeing that take cannibalization from core spirits.
Lavanya Chandrashekar (CFO)
In fact, we're seeing quite the reverse. Like, what we are seeing is that consumers coming into Bulleit ready to serve are then choosing to buy. A lot of them were not Bulleit drinkers, are now choosing to buy Bulleit, the base brand. So, we are seeing this as being quite incremental to us.
Mitch Collett (Director)
Understood. Thank you both.
Debra Crew (CEO)
Thanks.
Operator (participant)
Thank you. Our final question today comes from the line of Andrea Pistacchi from Bank of America. Please go ahead. Your line is now open.
Andrea Pistacchi (Managing Director)
Yes, thank you. Hi, Debra. Hi, Lavanya.
Debra Crew (CEO)
Hi.
Andrea Pistacchi (Managing Director)
Just wanted to compare a little, the U.S. with Europe. So you seem a bit more cautious on the U.S. for the next 6-12 months, given the environment, but you seem more confident on Europe, where you're also now lapping some big price increases. So the question is, what are you seeing really on the ground in Europe in terms of consumer pricing environment, and what is giving you this, I think, incremental confidence? Is it the difference that you're gaining share in Europe, the tequilas you're rolling out, or do you think you'll be able to take a bit more pricing this year?
Debra Crew (CEO)
Yeah.
Andrea Pistacchi (Managing Director)
Thank you.
Debra Crew (CEO)
I think it's, you know, it's several things, actually, and, you know, and some of them you mentioned. We are gaining share across most of Europe, which certainly helps us. And of course, Guinness being a big part of our gain in Ireland and GB, where Guinness is a big business, and so that certainly helps us. You know, the other thing is, you know, how our portfolio is arranged. Actually, in Europe, we have much more of a standard price portfolio. So if you think about, you know, I talk about our broad portfolio in the U.S., and we do feel like we can go wherever the consumer pivots to, but still Super Premium Plus is driving the growth in the U.S. market.
In Europe, we've got more of a standard price portfolio, which I think is helping us weather, you know, what's going on in Europe. And yet we do, we are gaining with some of the premiumization. So, you know, we're really getting both sets of benefits of kind of the now and the future, and we have a really full TBA portfolio that is helping us.
Andrea Pistacchi (Managing Director)
Okay, thank you.
Debra Crew (CEO)
But certainly, you know, I will add, we are lapping double-digit. We did call that out in the second half. We certainly, you know, I think we referenced resilient growth, but, you know, this is certainly a tough comp for us in Europe.
